Baker Market Update
2022-11-10

Friendly inflation data and apparent political gridlock have put financial markets in a good mood as this week draws to a close. As the dust settles on Tuesday’s elections, markets seem relatively pleased that neither party will have enough control to do too much damage. Centrists are celebrating. The real story, however, is the latest consumer price inflation numbers which show much needed relief as CPI eased to 7.7% YOY, lower than expected and well below September’s 8.2% pace. It is also the fourth consecutive drop and raises hopes for an acceleration of the downtrend. The core measure rose 6.3%, down from 6.6% in the prior month and also notably lower than estimated. To be sure, one month does not a trend make, and we remain at unacceptably high levels. Still, we are several months down the road from what appears to be the cycle peak of 9.1%. The developing trend looks good.

As post pandemic supply-shortages fade, deflationary pressure is now becoming manifest. Trade flows and transportation of materials have gradually improved after two years of sclerosis. Shippers and distribution networks have successfully developed workarounds that relieve the supply-shock inflation we’ve lived with since early 2020. That’s coupled with 400 basis points of fed tightening since March, which is starting to produce demand destruction that allows firms to hold off on price increases or to adjust their prices lower.

This has all got to be welcome news to policymakers. The markets absolutely love it. Stocks soared to the highest levels since August, and the 10yr Treasury yield collapsed to less than 3.85%, down from over 4.20% three days ago. The 2yr yield which is more closely tied to Fed policy has fallen even further, down 30bps to 4.33% and on pace for a two week low. The dollar finally pulled back on foreign exchange markets too, giving much needed relief to our trading partners.

As for monetary policy going forward, expectations for coming Fed rate hikes have been throttled back. A 50bps hike, rather than 75bps, is now the clear consensus. The futures market now implies a sharply lower terminal rate of 4.86% for next year, falling to 4.40% by the end of 2023. Fed officials acknowledge the good news but with caution. San Francisco president Mary Daly said, “one month of data does not a victory make…” and “pausing is not the discussion, the discussion is stepping down the pace of hikes”.

Next week we’ll get data on producer prices, retail sales, and housing starts among other things. Shout out to all Veterans on this holiday-shortened week.

US Consumer Price Inflation 2017 - Today